How to Compete with Legacy Incumbents
With Alex Niehenke, Partner at Scale Venture Partners
If you’re a Vertical AI founder going head-to-head with a legacy system of record — a multi-billion-dollar incumbent with dominant market share — how do you survive?
While this has always been an important question in vertical software, it’s become existential in the era of AI. As AI-native vertical solutions are growing with SaaS-defying velocity, incumbents are considering some permutation of the options:
Build internal AI teams
Acquire emergent AI point solutions
Cut off startup access (APIs / integrations) to their platforms
The founders who play this right can turn their incumbent relationships into an advantage — those that play it wrong risk getting steamrolled.
Alex Niehenke, Partner at Scale Venture Partners, has spent over a decade backing vertical startups, predominantly at Series A and B. Many of his portfolio companies — like Motive, Dusty Robotics, and Root Insurance — have faced the incumbent question. In today’s episode, Alex joins us to share his view on how Vertical AI startups should position themselves to win in markets with a handful of dominant players.
His framework: build a “system of love,” the system customers actually want to use. In industries where incumbents have jacked up prices for years — throwing around their weight to maintain control despite rock-bottom NPS — winning the early, fervent loyalty of your customers is critical. Because likely, you share those customers with an incumbent, and that may be your only leverage in an eventual, unfair match-up. On this episode of Verticals, Alex breaks down how Vertical AI founders should fight back, with some important nuances along the way.
We also revisit the “Death of SaaS” question, the milestones Series A investors are looking for in Vertical AI, and industries Alex would love to see more AI-native startups building in. Check out our episode here, and our breakdown of Alex’s founder playbook below.
This episode is brought to you by Parafin. At #15 on the Inc. 5000 and >$100M in revenue last year, they are flying. Makes sense when you realize they power customer financing offerings for the likes of Amazon, DoorDash, Kajabi, Gusto, and Worldpay. If you’re building a vertical platform and your customers need capital — they are a name you should know.
Alex’s Journey to Vertical AI Investor
Alex joined Scale in 2012 — back when vertical software was the lonely end of the dinner table. The perception was boring markets, tiny TAMs, cruddy buyers — and that turned out to be wrong. His partners once passed on a construction SaaS company out of Santa Barbara: “ten billion dollars later, we got Procore.” The seismic shift, in his view, came when foundational models spooked horizontal investors into the verticals. “Every venture firm suddenly has a vertical microsite,” he says.
He sees a structural reason Vertical AI stands out for VCs in the current era: investors are running from the risk that frontier models swallow horizontal software and running toward verticals where regulation, proprietary data, and workflow depth offer real moats. But Alex does warn that AI services without deep product embedding face a brutal commoditization curve. “Your margin is my opportunity. There’s always going to be some new YC kids who’ll do it cheaper.”
Check out the episode for a deep dialog on all of the above. Specifically, we thought his view on competing with legacy incumbents as a Vertical AI startup warranted a highlight — continue reading to get our breakdown of his top tips.
Vertical Playbook
How to Compete with Legacy Incumbents
Step 1: Build a System of Love
Incumbent ERPs in markets like legal, insurance, and construction have been running an inflation-plus pricing strategy for 15 years with no alternative in sight. Customers are furious. “Do you know who law firms hate? The traditional vendors — the Westlaws, LexisNexises.” When Harvey shows up and asks what problems they have, the floodgates open. Win on love and NPS, not contractual lock-in. “Think about where entrenched, miserable incumbents exist. That’s probably not a terrible framework.” The one true point of leverage you have when it comes to unfair fights with massive legacy incumbents is your shared customers — you want them to love you so much, they raise a fuss if and when the SoR makes integration hard.
Step 2: Build a Standalone Path Around the ERP
If a dominant ERP controls 40%+ of your market, a cutoff could wipe half your ARR overnight. The counter-move: make your product usable without the direct integration. Alex’s advice is to “vibe code that traditional system of record and roll it out” — build around them so that even if they turn hostile, your customers can still use your product and will be angry if it disappears.
Step 3: Don’t Litigate — Outrun
The Abridge/Epic standoff, Trunk Tools vs. Procore, Cumulate vs. AMS360 — Alex has watched these collisions up close. His verdict: avoid the courtroom. “The US litigation system’s timeline and costs don’t align with what you’re trying to solve at a startup level. You are litigating with somebody who has unlimited time, unlimited money, and they’re going to want to air out all your dirty laundry.” Channel the energy into shipping product instead. There’s growing precedent that the tide may be tipping against incumbents in the courtrooms — everyone should read about RTMS v. PointClickCare — but you don’t want to be an undercapitalized guinea pig.
Step 4: Give Up a Pound of Flesh If You Must
Alex invokes Dollar Shave Club: the viral hit that suddenly needed razor supply from one of five factories in the world — most owned by competitors. Founder Michael Dubin flew to Asia, gave up margin to secure supply, and preserved the momentum that ultimately led to a billion-dollar exit to Procter & Gamble. Sometimes, you negotiate with the ecosystem rather than fight it. Secure distribution while you still have velocity.
Step 5: Partner with the #2 and #3 ERPs
If the dominant system of record turns hostile, lean into the runners-up. Embed with them, co-sell with them, give them a reason to feature you as their innovation story. As Nic put it on the pod: “Go to the 2 and 3 and really try to have an embedded partnership with them” — at least until you’ve built enough platform defensibility to stand alone.
The Takeaway for Vertical Founders
The incumbents most vulnerable to disruption aren’t just bad at product — they’re often structurally incapable of responding. PE-owned, over-levered, run by hired-gun CEOs whose comp packages are designed not to cannibalize the base business. Alex is blunt: “Shame on those incumbent companies for being as shitty as they are.” But the reality is, that’s just how the incentives are stacked. That vacuum is exactly where the next generation of vertical platforms will be built — by founders with the conviction to build systems of love where love has been absent for a long time. And in addition to building a great product, success requires survival.
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